Tomorrow, the Federal Reserve will make decisions regarding interest rates. However, before that happens, investors will learn how inflation in the U.S. shaped up in November. The core index on an annual basis is expected to drop to 3.1 percent. In terms of monthly relations, it is supposed to be 0 percent. The base measure according to forecasts will remain at 4 percent year-on-year, and month on month it is expected to grow to 0.3 percent from the previous 0.2 percent. The dollar will react if we get a surprise in either direction. Higher readings than expected will cause the market to assume that the Fed will continue to maintain a “hawkish” stance, although further rate hikes are already seen as unrealistic by the market. In such a scenario, the USD will probably strengthen and U.S. bond yields will be rallied upwards again.
Both the general and base inflation measures in the U.S. show clear downward trends. The market will largely look at the month to month relationships. It is important to remember that the Fed’s inflation target of 2 percent on an annual basis corresponds to a value of about 0.17 percent on a monthly basis. With the latest data, the impression has probably strengthened that the inflationary impulse, which brought us such skyrocketingly high inflation rates in 2021/22, has finally been broken. However, the last stretch of disinflation to achieve the target may be more difficult and bumpy.
Unless today’s inflation data bring a huge surprise, the possibility of further interest rate hikes remains completely unrealistic from the market’s perspective. Pricing indicates that the Federal Reserve should start easing monetary policy somewhere around May or June. At one point the March move was quite realistic, but the latest NFP data reshaped the market’s overly optimistic assumptions.
If today’s U.S. inflation data surprise with a low level, it will be even harder for Powell to shift Fed expectations upwards tomorrow. There is a common view that his goal is to avoid too much easing of monetary policy now, and to prevent the disinflationary trend from ending prematurely. Any hawkish word from Powell tomorrow will be interpreted as a desire for further revision of market expectations regarding rapid start of interest rate cuts in the U.S.
By:Łukasz Zembik Oanda TMS Brokers
